Marijuana Legalization: How Investors Can Profit!

Here’s where to start if you want to go for the green.

Motley Fool Staff
Motley Fool Staff
Jul 29, 2019 at 1:42PM
Health Care

If you're not sure where to begin when it comes to capitalizing on cannabis, you're not alone. But it's not hard to learn the legal landscape and develop an understanding of some of the best pot stocks available.

Narrator: Cannabis is the latest hot commodity to take markets by storm, and many public companies are benefiting from global growth in new markets for recreational and medical marijuana, as well as hemp and cannabidiol, also called CBD.

In 2018, global cannabis sales reached $12.2 billion and in 2019, sales should soar to $16.9 billion. Some analysts estimate that annual marijuana sales could eventually reach $166 billion.

While sales likely won't approach that figure in the next ten years, it's still clear this opportunity is huge — and that has investors excited.

Marijuana is legal for medical use in more than 40 countries and for recreational use in Canada and Uruguay. In the U.S., 33 states have legalized medical use, and 10 states plus D.C. allow recreational use.

But on a federal level, marijuana remains illegal in the U.S. and is classified by the Drug Enforcement Administration as a Schedule 1 substance.

Future sales growth will be driven by new markets opening, new products, pot companies scaling, and the growth of the U.S. hemp market, which has seen explosive popularity since President Trump signed the U.S. Farm Bill, legalizing hemp products like CBD.

Now that we've gotten a lay of the land, let's discuss how investors find pot stocks that will become multibaggers over time! Let's start by looking at two different ways to invest in cannabis.

First, is the Pure Play approach, in which you invest in a company directly involved in the marijuana or hemp industries.

The biggest marijuana producers, all based in Canada, are Canopy Growth (NYSE:CGC), Aurora Cannabis (NYSE:ACB), Cronos Group  and Tilray (NASDAQ:TLRY). But they're not the only pure way to play the market.

Charlotte's Web (OTC:CWBHF) sells CBD oil, which doesn't elicit the "high" effect marijuana is known for. And MedMen (OTC:MMNFF) operates North American marijuana dispensaries, and its seven California facilities make more in sales per square foot than Apple or Tiffany & Co.

For investors interested in profiting from pot ancillary products, KushCo (OTC:KSHB) generates all its revenue from the cannabis industry by selling marijuana packaging solutions.

When you're analyzing stocks in the cannabis space, look for a couple of things in particular:

  1. Profitability: Few marijuana stocks are profitable yet. Try to determine how quickly it will become profitable and how it's funding operations in the meantime.
  2. Stock dilution: Pot companies haven't had traditional access to capital in the past, so many depended on financing through issuing shares, which resulted in diluting the available stock. Look at the shares outstanding and the company's share issuance history.

Specifically, for marijuana producers, there are two key metrics to know.

  1. Peak production capacity: Estimate in kilograms of how much cannabis can be grown under ideal conditions.
  2. Cost of sales per gram: The less it costs to produce, the better off a producer will be when supply exceeds demand.

The second way to invest in marijuana stocks is by looking at established companies that have ventured into cannabis either directly, or indirectly. This strategy exposes investors to cannabis' upside, while protecting returns from the risk that sustainable growth doesn't pan out.

For example, Corona maker Constellation Brands (NYSE:STZ) invested $4 billion into Canopy. Molson Coors Brewing (NYSE:TAP) and Anheuser-Busch InBev (NYSE:BUD) are also exploring CBD-infused beverage ventures. Cigarette maker Altria (NYSE:MO) bought a 45% stake in Cronos Group. And the e-commerce platform company, Shopify (NYSE:SHOP), also enjoys growth from online cannabis sales arrangements with governments and pot companies.

These companies already have rock-solid core businesses, but could enjoy a big boost from the marijuana industry.

When analyzing cannabis stocks, consider the usual core metrics you'd look at for any stock, including revenue growth, net debt, and earnings history. Next, you'll want to get a feel for how much the company stands to gain or lose from its foray into pot.

Compare its revenue from existing operations and make sure you understand just how big its bet is on the marijuana market.

Are you ready to invest in pot stocks? If you meet these criteria, cannabis might deserve a spot in your portfolio.

  1. First, make sure you don't need the money for at least five years. Cannabis is a fledgling industry that might not pay off. You need time for your investment to generate a solid rate of return coupled with patience to bear any dips or prolonged weakness.
  2. Second, own other investments. Investing in cannabis is a great supplement to an already diversified portfolio, but it shouldn't be the only industry you're investing in.

Finally, know the market and its risks. Only buy cannabis companies you understand.

Not surprisingly, the marijuana market is just like any other industry. You need to understand what you own, otherwise, you're just speculating -- not investing.